2017-09-28

China Rebound or Head Fake? Red Line Approaches

For the past year, a commodities rebound has pointed to a rebound in the global economy. As a skeptic of this growht, I've been wondering how much of the global "rebound" (the data is less bad, not great) was driven by Chinese credit growth and how much was a real turnaround.

By digging out the cause behind the rally of industrial indicators and looking into China’s growth engines, we think it is premature to draw such a rosy conclusion at this stage.

A closer examination on the increased industrial profits since last year showed that the improvements were not spread out evenly across sectors and various types of producers — specifically, upstream sectors such as coal, metallic metal, oil and gas mining and midstream manufacturers in heavy industry — wherein large state-owned enterprises preponderated, accounting for most of the rebound in profits.

...The varying profitability made sense, for the substantial growth up till now stemmed from China’s “supply-side structural reform,” intended to cut capacity in heavy industry since early 2016. As steel mills and coal mines were shut, supply decreased and price soared.

I'm not sure what this last sentence means, steel production is near record highs. And how about aluminum?

China’s aluminum industry is being hit by a double whammy — forced closures of unapproved plants to curb overcapacity and heavy cuts in production over the winter months to ease choking pollution. But the bad news has been good news for investors, speculators and some companies.

The price of the metal, which is used in a wide range of industries including aerospace, construction and packaging, has surged in domestic markets as speculators anticipated a repeat of the bull market already seen in coal and steel after the government ordered cuts in capacity and output in those industries.

...“The current market boom is not being caused by (changes in) the relationship between supply and demand,” Wang Qiang, an industry insider close to policymakers, told Caixin. “It’s being caused by speculation funded by borrowed money.”

How about those production cuts?

Desperate aluminum producers scaled back output at the end of 2015 in a bid to boost prices, which Antaike described as the “largest cutback in nearly seven years.” As a result, production of the metal rose by only 1.3% in 2016 to 31.87 million tons, collapsing from 2015’s growth rate of 11.3%, NBS data show.

...Production is still outpacing demand, however. In the first half of this year, total output jumped by 20.9%, while consumption only rose by 11.5%, data cited by Chalco show.

China uses the same math as politicians in Washington, where a cut is a reduction in the rate of growth, not an actual reduction. China isn't cutting, it is slowing the buildup of overproduction and inventory in the hopes that a jump started economy will absorb the supply. China is getting worse more slowly than before.

Back to the econ article:

Even though corporate treasurers decide to invest in fixed assets as profits rise further, the credit environment may not be in their favor. China ranked the highest in the ratio of nonfinancial corporate borrowing to gross domestic product (GDP), surging from 99% to 170% since the global financial crisis. As the debt risks drew increasing attention, this year the financial regulatory authorities have strengthened supervision to prevent systematic financial risks. The interest rates rose significantly, resulting in higher costs of financing investment. And there is no sign of loosening monetary policy in the short run.
ng 3.9% and 3.8% respectively, in contrast to 4.6% in June. More essentially, China’s investment-led growth has run out of steam. The proportion of investment in GDP has plummeted from 86.5% in 2009 to around 41% in 2016. Since the global financial crisis, China’s investment has been mainly driven by a booming property market and infrastructure financed by local government debts. But their roles are also fading as the housing market showed signs of stabilizing and Beijing pledged to curb government debts. What matters more: None of these factors is unconventional, which cannot justify a new boom cycle.

...The most important event in China this year will come soon. The National Congress of the Communist Party is expected to convene on Oct. 18. Will it herald a new round of reform in China? Only reform can unleash China’s growth potential. The reform package should include restructuring state-owned enterprises and opening the service sector to genuinely embracing private investment. Allowing private capital to engage in health care, education, communication, etc., is essential to improving social infrastructure and encouraging consumption. Plus, China should promote urbanization and environmental protection in a more market-oriented manner, advancing the transition to a more-sustainable, inclusive growth.